What is Value Added Tax (VAT)?

Value Added Tax (VAT) is correctly defined as a consumption tax that is levied at each stage of production or distribution, based on the value added to goods and services. This mechanism means that businesses charge VAT on their sales and are allowed to reclaim the VAT they pay on their purchases, effectively taxing only the value they add to a product.

This system allows for tax neutrality because it avoids the cumulative effect of tax on tax seen in some other tax structures, ensuring that the burden of VAT is passed along the supply chain while being ultimately borne by the final consumer. VAT is collected incrementally at different stages, such as when raw materials are sold to manufacturers, when these manufacturers sell their products to wholesalers, and when wholesalers sell to retailers.

Other definitions refer to specific types of taxes unrelated to VAT. For instance, taxes on capital gains or real estate sales pertain to profit made from the sale of assets or property rather than consumption. Similarly, a tax added to the income of businesses does not accurately reflect VAT, as it is not based on profit but rather on consumption and the value added at each step in the production and distribution process. Thus, the understanding that VAT is specifically focused on consumption, and that it operates throughout the supply chain,